Principles of Economics

Twelfth Edition

CHAPTER 4
DEMAND, SUPPLY,
AND MARKET
EQUILIBRIUM

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Demand
• Demand is the quantity of a good/product or service that
people are willing and able to purchase at every possible
price.
• Demand is a relationship between the price of a good or
service and the quantity of that good or service people are
willing and able to buy.
• The Law of Demand (an inverse relationship between price
and quantity demanded)

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Demand
• A household’s decision about what quantity of a particular
output, or product, to demand depends on a number of
factors, including:
– The price of the product in question
– The income available to the household
– The household’s amount of accumulated net wealth
– The prices of other products available to the
household
– The household’s tastes and preferences
– The household’s expectations about future income,
wealth, and prices

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• quantity demanded The amount (number of units) of a
product that a household would buy in a given period if it
could buy all it wanted at the current market price.
• It is important to focus on the price change alone with the
ceteris paribus, or “all else equal,” assumption.

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• Changes in the price of a product affect the quantity
demanded per period.
• Changes in any other factor, such as income or
preferences, affect demand.
• Thus, we say that an increase in the price of Coca-Cola is
likely to cause a decrease in the quantity of Coca-Cola
demanded. However, we say that an increase in income is
likely to cause an increase in the demand for most goods.

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The Law of Demand
• demand schedule Shows how much of a given product
a household would be willing to buy at different prices for a
given time period.
• demand curve A graph illustrating how much of a given
product a household would be willing to buy at different
prices.

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TABLE 3.1 Alex’s Demand FIGURE 3.2 Alex’s Demand
Schedule for Gasoline Curve
Quantity
Price Demanded
(per gallon) (gallons per week)
$8.00 0
7.00 2
6.00 3
5.00 5
4.00 7
3.00 10
2.00 14
1.00 20
0.00 26

The relationship between price (P) and quantity demanded

(q) presented graphically is called a demand curve.
Demand curves have a negative slope, indicating that lower
prices cause quantity demanded to increase.
Note that Alex’s demand curve is blue; demand in product
markets is determined by household choice.

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Demand Curves Slope Downward
• law of demand The negative relationship between price
and quantity demanded: Ceteris paribus, as price rises,
quantity demanded decreases; as price falls, quantity
demanded increases during a given period of time, all
other things remaining constant.
• It is reasonable to expect quantity demanded to fall when
price rises, ceteris paribus, and to expect quantity
demanded to rise when price falls, ceteris paribus.
• A demand curve has a negative slope.

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Other Properties of Demand Curves
• To summarize what we know about the shape of demand
curves:
1. They have a negative slope.
2. They intersect the quantity (X) axis, a result of time
limitations and diminishing marginal utility.
3. They intersect the price (Y) axis, a result of limited
income and wealth.
• The actual shape of an individual household demand curve
depends on the unique tastes and preferences of the
household and other factors.
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Other Determinants of Household
Demand
Income and Wealth
• income The sum of all a household’s wages, salaries,
profits, interest payments, rents, and other forms of
earnings in a given period of time. It is a flow measure.
• wealth or net worth The total value of what a household
owns minus what it owes. It is a stock measure.

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Income and Wealth
• normal goods Goods for which demand goes up when
income is higher and for which demand goes down when
income is lower.
• inferior goods Goods for which demand tends to fall
when income rises.

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Prices of Other Goods and Services
• substitutes Goods that can serve as replacements for
one another; when the price of one increases, demand for
the other increases.
• perfect substitutes Identical products.
• complements, complementary goods Goods that “go
together”; a decrease in the price of one results in an
increase in demand for the other and vice versa.

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Tastes and Preferences
• Changes in preferences can and do manifest themselves
in market behavior.
• Within the constraints of prices and incomes, preference
shapes the demand curve, but it is difficult to generalize
about tastes and preferences.

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Expectations
• What you decide to buy today certainly depends on today’s
prices and your current income and wealth.
• Increasingly, economic theory has come to recognize the
importance of expectations.
• It is important to understand that demand depends on
more than just current incomes, prices, and tastes.

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Shifts of Demand versus Movement
along a Demand Curve ( 1 of 2)
• shift of a demand curve The change that takes place in
a demand curve corresponding to a new relationship
between quantity demanded of a good and price of that
good. The shift is brought about by a change in the original
conditions.
• movement along a demand curve The change in
quantity demanded brought about by a change in price.

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TABLE 3.2 Shift of Alex’s Demand Schedule Resulting from an
Increase in Income

Schedule D0 Schedule D1
Quantity Demanded Quantity Demanded
Price (Gallons per Week at an (Gallons per Week at an
Income of Income of $700 per
(per Gallon) $500 per Week) Week)
$8.00 0 3
7.00 2 5
6.00 3 7
5.00 5 10
4.00 7 12
3.00 10 15
2.00 14 19
1.00 20 24
0.00 26 30

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FIGURE 3.3 Shift of a Demand Curve Following a Rise in Income

When the price of a good changes, we

move along the demand curve for that
good.

When any other factor that influences

demand changes (income, tastes, and
so on), the demand curve shifts, in this
case from D0 to D1.

Gasoline is a normal good, so an

income increase shifts the curve to the
right.

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Shifts of Demand versus Movement
along a Demand Curve (2 of 2)
• Change in price of a good or service leads to
change in quantity demanded (movement along a
demand curve).
• Change in income, preferences, or prices of other goods or
services leads to
change in demand (shift of a demand curve).

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FIGURE 3.4 Shifts versus Movement along a Demand Curve (1 of 2)

a. When income increases, the demand for inferior goods shifts to the left, and the demand for normal
goods shifts to the right.

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 FIGURE 3.4 Shifts versus Movement along a Demand Curve
(cont’d 2 of 2)

b. If the price of hamburger rises, the quantity of hamburger demanded declines; this is a movement along
the demand curve.
The same price rise for hamburger would shift the demand for chicken (a substitute for hamburger) to the
right and the demand for ketchup (a complement to hamburger) to the left.

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From Household Demand to Market
Demand
• market demand The sum of all the quantities of a good or
service demanded per period by all the households buying
in the market for that good or service.

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FIGURE 3.5 Deriving Market Demand from Individual Demand
Curves

Total demand in the marketplace is simply the sum of the demands of all the households shopping in a
particular market. It is the sum of all the individual demand curves—that is, the sum of all the individual
quantities demanded at each price.

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Supply
• Firms build factories, hire workers, and buy raw materials
because they believe they can sell the products they make
for more than it costs to produce them.
• profit The difference between revenues and costs.

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The Law of Supply
• quantity supplied The amount of a particular product that
a firm would be willing and able to offer for sale at a
particular price during a given time period.
• supply schedule Shows how much of a product firms will
sell at alternative prices.

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• law of supply The positive relationship between price and
quantity of a good supplied: An increase in market price,
ceteris paribus, will lead to an increase in quantity
supplied, and a decrease in market price will lead to a
decrease in quantity supplied.
• supply curve A graph illustrating how much of a product
a firm will sell at different prices.

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TABLE 3.3 Clarence Brown’s FIGURE 3.6 Clarence
Supply Schedule for Brown’s Individual Supply
Soybeans Curve
Price (per Quantity Supplied
Bushel) (Bushels per Year)
$1.50 0
1.75 10,000
2.25 20,000
3.00 30,000
4.00 45,000
5.00 45,000

A producer will supply more when the price of output

is higher. The slope of a supply curve is positive.

Note that the supply curve is red: Supply is

determined by choices made by firms.

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Other Determinants of Supply
The Cost of Production
• For a firm to make a profit, its revenue must exceed its
costs.
• Cost of production depends on a number of factors,
including the available technologies and the prices and
quantities of the inputs needed by the firm (labor, land,
capital, energy, and so on).

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The Prices of Related Products
• Assuming that its objective is to maximize profits, a firm’s
decision to supply depends on:
1. The price of the good or service
2. The cost of producing the product, which in turn
depends on:
 The price of required inputs (labor, capital, and land)
 The technologies that can be used to produce the
product
3. The prices of related products

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Shift of Supply versus Movement along
a Supply Curve ( 1 of 2)
• movement along a supply curve The change in quantity
supplied brought about by a change in price.
• shift of a supply curve The change that takes place in a
supply curve corresponding to a new relationship between
quantity supplied of a good and the price of that good. The
shift is brought about by a change in the original
conditions.

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TABLE 3.4 Shift of Supply Schedule for Soybeans following
Development of a New Disease-Resistant Seed Strain

Schedule S0 Schedule S1
Quantity Supplied Quantity Supplied
Price (Bushels per Year (Bushels per Year
(per Bushel) Using Old Seed) Using New Seed)
$1.50 0 5,000
1.75 10,000 23,000
2.25 20,000 33,000
3.00 30,000 40,000
4.00 45,000 54,000
5.00 45,000 54,000

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FIGURE 3.7 Shift of the Supply Curve for Soybeans Following
Development of a New Seed Strain

When the price of a

product changes, we
move along the supply
curve for that product; the
quantity supplied rises or
falls.

When any other factor

affecting supply changes,
the supply curve shifts.

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Shift of Supply versus Movement along
a Supply Curve (2 of 2)
• It is very important to distinguish between movements
along supply curves (changes in quantity supplied) and
shifts in supply curves (changes in supply):
• Change in price of a good or service leads to
change in quantity supplied (movement along a
supply curve).
• Change in costs, input prices, technology, or prices of
related goods and services leads to
change in supply (shift of a supply curve).

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From Individual Supply to Market Supply
• market supply The sum of all that is supplied each period
by all producers of a single product.

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FIGURE 3.8 Deriving Market Supply from Individual Firm Supply
Curves

Total supply in the marketplace is the sum of all the amounts supplied by all the firms selling
in the market. It is the sum of all the individual quantities supplied at each price.

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FIGURE 3.8 Deriving Market Supply from Individual Firm Supply
Curves (cont’d)

Total supply in the marketplace is the sum of all the amounts supplied by all the firms selling
in the market. It is the sum of all the individual quantities supplied at each price.

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Market Equilibrium
• equilibrium The condition that exists when quantity
supplied and quantity demanded are equal. At equilibrium,
there is no tendency for price to change.
Excess Demand
• excess demand or shortage The condition that exists
when quantity demanded exceeds quantity supplied at the
current price.

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FIGURE 3.9 Excess Demand, or Shortage

At a price of $1.75 per bushel, quantity demanded exceeds quantity supplied.

When excess demand exists, there is a tendency for price to rise.

When quantity demanded equals quantity supplied, excess demand is eliminated and the market is in
equilibrium.

Here the equilibrium price is $2.00, and the equilibrium quantity is 40,000 bushels.
Here the equilibrium price is $2.00, and the equilibrium quantity is 40,000 bushels.

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Excess Supply
• excess supply or surplus The condition that exists when
quantity supplied exceeds quantity demanded at the
current price.
• When quantity supplied exceeds quantity demanded at the
current price, the price tends to fall.
• When price falls, quantity supplied is likely to decrease,
and quantity demanded is likely to increase until an
equilibrium price is reached where quantity supplied and
quantity demanded are equal.

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FIGURE 3.10 Excess Supply, or Surplus

At a price of $3.00, quantity supplied exceeds quantity demanded by 40,000 bushels.

This excess supply will cause the price to fall.

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Changes in Equilibrium
• When supply and demand curves shift, the equilibrium
price and quantity change.

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FIGURE 3.11 The Coffee Market: A Shift of Supply and Subsequent
Price Adjustment

Before the freeze, the coffee

market was in equilibrium at a
price of $1.20 per pound.

At that price, quantity

demanded equaled quantity
supplied.

The freeze shifted the supply

curve to the left (from S0 to S1),
increasing the equilibrium price
to $2.40.

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FIGURE 3.12 Examples of Supply and Demand Shifts for Product X

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 Demand and Supply in Product Markets:
A Review (1 of 2)
• Important points to remember about the mechanics of supply
and demand in product markets:
1. A demand curve shows how much of a product a household
would buy if it could buy all it wanted at the given price. A
supply curve shows how much of a product a firm would
supply if it could sell all it wanted at the given price.
2. Quantity demanded and quantity supplied are always per
time period—that is, per day, per month, or per year.
3. The demand for a good is determined by price, household
income and wealth, prices of other goods and services,
tastes and preferences, and expectations.

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4. The supply of a good is determined by price, costs of
production, and prices of related products. Costs of production
are determined by available technologies of production and
input prices.
5. Be careful to distinguish between movements along supply
and demand curves and shifts of these curves. When the price
of a good changes, the quantity of that good demanded or
supplied changes—that is, a movement occurs along the
curve. When any other factor changes, the curve shifts, or
changes position.
6. Market equilibrium exists only when quantity supplied equals
quantity demanded at the current price.

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Looking Ahead: Markets and the
Allocation of Resources
• You can see how markets answer the basic economic
questions of what is produced, how it is produced, and
who gets what is produced:
• Demand curves reflect what people are willing and able to
pay for products; they are influenced by incomes, wealth,
preferences, prices of other goods, and expectations.
• Firms in business to make a profit have a good reason to
choose the best available technology—lower costs mean
higher profits.
• When a good is in short supply, price rises. As it does, only
those who are willing and able to continue buying do so.

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